Updated from 3:10 p.m. EST
left interest rates unchanged Wednesday but tweaked its policy statement by saying it would be "patient" before embarking on a rate hike.
The central bank's statement closely mimicked the one it issued in December and continued to balance positive comments about the economy with caution about the low level of inflation and slack resource use. But the Fed did make one crucial change in dropping its commitment to keep rates on hold for a "considerable period."
"I think sooner or later the Fed would have had to abandon that term considerable period if only to prime the financial markets for the eventual need to more closely align the federal funds rate with a livelier pace of economic activity," said John Lonski, senor economist at Moody's Investors Service. "But by no means does this particular statement imply that the Fed is on the verge of lifting the federal funds rate."
Nevertheless, stocks and bonds sold off on the news and the dollar moved higher. The 10-year Treasury note went from up 9/32 to down 1 11/32, yielding 4.24%, shortly after the announcement. It was recently down 26/32 to yield 4.17%. Meanwhile the
tumbled 141 points and the
was off by almost 2%.
"The evidence accumulated over the intermeeting period confirms that output is expanding briskly," the Fed said in its statement. "With inflation quite low and resource use slack, the committee believes that it can be patient in removing its policy accommodation."
The Fed said the upside and downside risks to the attainment of sustainable growth for the next few quarters are roughly equal. It also said the probability of an unwelcome fall in inflation has diminished and now appears almost equal to that of a rise in inflation.
The central bank noted that while new hiring remains subdued, other indicators suggest an improvement in the labor market. In the previous statement, the Fed said the labor market "appears to be improving modestly."
Economists had widely expected the Fed to keep interest rates unchanged at 1% but pundits had not anticipated a change in the policy statement. "We think this is simply a rewording, rather than a change in Fed's accommodation policy as it conveyed that it 'can be patient in removing its policy accommodation,'" said Ashraf Laidi, chief currency analyst at MG Financial Group.
Tony Crescenzi, chief bond strategist at Miller Tabak and contributor to
, said the odds of a fed funds rate hike in June now stand at 72%, up from 45% prior to the Fed's announcement.
"I think it's actually an excellent transition statement," he said. "The Fed essentially said 'hey we probably will have to raise interest rates this year but don't worry we can be patient about the removal of the stimulus.'"
Crescenzi said this should be comforting to stock investors, in part because it suggests the economy is strengthening. But it does change the dynamic for investors who have been taking advantage of the so-called carry trade. Bond traders, commercial banks and other institutional investors borrow short-term funds and invest the money at higher rates. When the yield curve starts to flatten, investors are often forced to unwind those trades.
Ethan Harris, senior economist at Lehman Brothers, doesn't think the carry trade is at risk just yet because he believes that the Fed will indeed be patient in raising rates. "I don't think the Fed is about to pull the trigger," he said. "I think this is a baby step towards tightening."
The two key measures that the Fed looks at in determining monetary policy; inflation and employment remain subdued for now and are a long way from the thresholds that would make central bankers nervous, Harris said.
"Monetary policy is firmly on hold, and will probably remain so unless inflation moves higher," agreed Maury Harris, chief economist at UBS Investment Research. "But Fed officials appear to be preparing for potential tightening later this year."
Harris is expecting a 25 basis point increase in August. "Our forecast is premised on some acceleration in core consumer prices, a clear pickup in the job market, and continued solid growth between now and August," he said.